One of the most important contract a business owner can make is a Buy-Sell Agreement. Unfortunately, it’s a contract few business owners take the time to make. In its basic form, a buy-sell agreement controls who gets the owner’s share of the business when he dies or becomes disabled.
An example: You and your partner started and operate your business. Your partner dies, and his wife and kids end up owning his share of the business. Do you want to be partners with his wife and kids? They may be nice people, but they can’t replace your partner. They don’t know the business and don’t have the skills to take on his responsibilities. You would like to buy out your deceased partner’s share from his family, and they would like the cash, but you have no cash. As a result, your partner’s wife and kids become your new partners with a one-half ownership and one-half controlling share of the business. They contribute nothing to the ongoing success of the business, but they have a say in all your business decisions.
You have no liquidity to buy them out, but they need the cash, so they may offer to sell their share to a third party, maybe even a competitor. The third party buyer, knowing the company has lost a key employee/owner, may make a lowball offer. The deceased partner’s family, desperate to replace their husband/father’s income will settle for any price, and they sell. The only thing worse than your partner’s family as your partner is a complete stranger, who may even be a competitor, as your partner.
Unfortunately, this happens. The solution is a buy-sell agreement with life insurance policies. In the above example, this can be done with a cross-purchase agreement. A cross-purchase agreement is a type of buy-sell agreement in which each partner purchases a life insurance policy on the life of the other. The agreement defines how the surviving partner will purchase the interest of the deceased partner, including how to value the business, the purchase price and terms. With a cross purchase agreement funded with life insurance, the surviving partner would have ready cash upon the death of his partner to buy out the partner’s family pursuant to the terms of the agreement. This is a win-win. The surviving partner has the funds, through the life insurance to buy the business and the surviving family members gets what they really want, cash in exchange for the business. |
